Damage control, or how to sue your contractor.

Property owners faced with consequential damages stemming from a contractor's breach of contract may believe they have no recourse. However, careful drafting of the contract can protect their interests. First, owners must understand the difference between consequential damages and compensatory damages.

Compensatory damages are those which are most directly related to a contractor's failure to complete a project. For example, compensatory damages include the cost of finishing the project, as well as any repairs of inferior or deficient work by the contractor. Consequential damages are one step removed and include what the owner should have reasonably been able to expect had the contractor lived up to the terms of the contract. A good example of compensatory damages is the loss of rental income which the owner expected to derive once the project was finished. Other examples include losses incurred due to lease terminations and increased financing expenses. Due to their nature, compensatory damages can be difficult to calculate.

To address this factor, many attorneys will advise their clients to include a liquidated damages clause in their contracts. The liquidated damages clause assesses liability for each day of delay until completion. They believe, incorrectly, that the clause will be upheld if a contractor fails to complete or abandons a project rather than fails to meet the agreed upon completion date. In reality, many common liquidated damages clauses are invalid when applied to contractors who fail to complete or abandon a project. Owners, however, are not without recourse.

By incorporating certain clauses and language within the contract, owners can recover consequential damages resulting from a contractor's failure to complete a project or project abandonment. They include the following:

A "time is of the essence clause"--In contracts where the liquidated damages clause is invalid, the courts will allow an owner to invoke this clause to recover damages, provided the property owner can demonstrate an accurate calculation of consequential damages. This requires evidence that, for example, there was a tenant lined up and thus rental income was lost for "X" number of months; that the rental income had, in fact, increased as validated by a real estate valuation expert witness; or, that additional financing was needed as documented by a letter from the bank.

A "liquidated damages clause addressing potential failure to complete or project abandonment by the contractor"--This requires that the owner's contract include language such as: "The contractor acknowledges that the owner will suffer damages if the contractor either (1) fails to complete the project within the specified time noted in the schedule, or (2) abandons the project or its work prior to substantial or final completion."

A "hybrid consequential damages clause"--This clause assesses a specified amount of money per day for a specified number of months if the owner doesn't finish the work within the contractual completion date after the contractor abandons the project and which provides that the owner is entitled to actual consequential damages thereafter. It is important that the owner exercise good judgment when determining the number of months to be covered under liquidated damages, based on actual experience relating to construction delays. The court is likely to uphold a liquidated damages clause which it finds to be "reasonable" and not excessive. The hybrid consequential damages clause is particularly valuable for owners who want to circumvent having to calculate actual consequential damages, while still retaining their right to these damages should a project's completion take an excessively long time.

Owners seeking consequential "damages in those situations when the contractor does complete the project, but not within the specified schedule, can and should protect their interests using a traditional liquidated damages clause. It should assess a certain amount of money per day of delay until substantial completion and a certain amount of money per day of delay thereafter until final completion.

However, it is prudent for an owner to include a hybrid consequential damages clause, combining liquidated damages and actual consequential damages after the expiration of the liquidated damages time period.

These contract guidelines should be followed to avoid difficulties in gaining rightful consequential damages.